Page 11 - Payroll

Timing & Taxation

of Self-Employed

Earnings

Because self-employed individuals have control over when and if they take home
earnings from a business, the IRS taxes the individual on the net earnings of the business
as of December 31st of each tax year. The business net income is taxed when earned, not
when taken home. The timing of distributions to the owner is irrelevant in determining
the tax due each year (as long as there is basis for such distributions, which is beyond the
scope of this booklet)

For Example, In Business to Make Money, LLC has the following earnings and
distributions for tax year ended December 31, 2020:

Gross sales from product: $200,000
Total business expenses: $75,000
NET INCOME FROM OPERATIONS: $125,000

Distributions to owner (total of $90,000 in 2020 plus an additional $15,000 in 2021):
$30,000 on March 18, 2020
$15,000 on July 2, 2020
$45,000 on October 21, 2020
$15,000 on January 7, 2021

To compute the amount of tax due on the owner's 2020 Form 1040, the details from
business operations will be shown on the Schedule C, which will then show a net profit
of $125,000 on the front of the Form 1040 to be included in the tax calculation for 2020.
The owner will owe federal tax at their ordinary income tax rate, plus FICA (Social
Security & Medicare) tax on this amount, which should be covered by estimated tax
payments throughout the year.

NOTE: The amount and timing of the distributions to the owner or partners are not
relevant to the tax due calculation on the Form 1040. Although the timing of taxation
and distributions makes things confusing, this means there is no double taxation when
you take the $15,000 distribution in 2021. You already paid tax on that money on your
2020 tax return, as part of the $125,000 net income. You just hadn't taken it home yet.

Page 9 Terri Johnson, CPA